Straining Conceptual Consistency: Home Buyers as Financial Creditors

[M P Ram Mohan is Associate Professor, Indian Institute of Management Ahmedabad and Vishakha Raj a Research Associate, Strategy Area, Indian Institute of Management Ahmedabad.

This post is based on the authors’ article Apartment Buyers as Financial Creditors: Pushing the Conceptual Limits of the Indian Insolvency Regime published in the Columbia Journal of Asian Law]

A unique feature of the Indian insolvency regime is its classification of debt into “operational” and “financial” debt, thus creating operational and financial creditors. Operational debt is characterized as dues payable by the corporate debtor for services and goods consumed (instances include payments to employees and suppliers). Financial debt refers to dues that represent a solely financial relationship between the debtor and creditor. A key feature of all financial debt as explained in the Insolvency and Bankruptcy Code, 2016 (IBC) under section 5(8)(f) is that it must comprise disbursements against the “time value of money.”

In 2018, the IBC was amended to include amounts raised from allottees (persons to whom an apartment or plot in a real estate project has been allotted) within the definition of financial debt, thus making allottees financial creditors. Though the amendment was recommended and enacted to empower allottees in India’s real estate sector, it seems to dilute the definition of what characteristics are germane to the classification of financial creditors under the IBC. This reduces the clarity with which stakeholders can ascertain whether they are financial or operational creditors. The focus of categorizing debts seems to have shifted from the nature of the debt to the relative vulnerability of the creditors (in this case apartment buyers).  

The 2018 amendment was challenged, albeit unsuccessfully, before the Supreme Court of India in Pioneer Urban Land & Infrastructure Limited v. Union of India on the grounds that apartment buyers were more suited to the category of operational creditors than financial creditors. The 2018 amendment, its rationale and the litigation surrounding it have provided an opportunity to scrutinize the characteristics of financial and operational creditors as delineated by the IBC. Clarity in understanding this classification is significant in the Indian context as only financial creditors have the ability to vote on insolvency resolution plans that decide how the corporate debtor will be reorganized. When one is a financial creditor, they also have an easier path to initiate insolvency resolution proceedings against the corporate debtor who is not allowed to dispute the default.[1]

The Centrality of Time Value of Money to Financial Debt

The key conceptual justification for the 2018 amendment equates the substantial investment apartment buyers make when buying homes to moneys disbursed by financial creditors. The Report of the Insolvency Law Committee, 2018 (ILC Report) which recommended the amendment noted that apartment buyers pay large sums of money to developers only to be met with delays and incomplete projects. This problem certainly deserves regulatory attention, and even recognition during the developer’s insolvency proceedings; however, characterizing apartment buyers as financial creditors risks stretching the conceptual limits of the IBC.

While it is true that apartment buyers disburse money to the developer, they do not do this in return for consideration for time value of money. Time value of money essentially represents opportunity cost or other ventures in which the money could have been injected. For apartment buyers, this opportunity cost becomes less clear; a better characterization of their disbursal to the developer is an advance consideration. This is why in Nikhil Mehta and Sons v. AMR Infrastructure Ltd the National Company Law Appellate Tribunal (NCLAT) held that apartment buyers could be considered financial creditors only under specific circumstances – when they received assured returns from the real estate developer for their advances as consideration. The consideration for time value of money (such as payment of interest) that is a key element of identifying financial debt under the IBC is not present in all transactions between an apartment buyer and real estate developer. The ILC Report generalizes the nuanced finding of the NCLAT in Nikhil Mehta regarding when apartment buyers can be considered financial creditors. The NCLAT held that the periodic payments for the apartment buyers’ disbursements by the real estate developer constituted the consideration for the item value of money. Further, when the element of committed returns is present, the transaction can be characterized as purely financial as the returns are there to induce the initial disbursement which may not have occurred simply to secure the construction of the flat.

In the absence of the element of committed returns, the transaction between apartment buyers and financial creditors would simply be one for the purchase of a service (construction of an apartment). This type of transaction would seem to fit the definition of an operational creditor, but its arrangement is different when compared to a typical operational creditor (such as an employee or supplier). This is because when a supplier of raw material is a financial creditor, the corporation owes the supplier payments for the product supplied. In the context of apartment buyers, what is owed by the corporate debtor is not money but a service (construction and delivery of an apartment). This reasoning was used by the Supreme Court to hold that apartment buyers could not be operational creditors.

In Overseas Infrastructure Alliance (India) Pvt Ltd v. Kay Bouvet Engineering Ltd, however, the NCLAT held that receivers of goods and services would be considered operational creditors. Here, a sub-contractor did not refund sums that were extended to it for the construction of a sugar mill. When insolvency proceedings were filed against the sub-contractor for the sums paid, the NCLAT found that it was an operational debtor. This case appears to be analogous to that of the apartment buyer – in both instances a service (against advance payment) is owed by the corporate debtor rather than money. If one were to use the Supreme Court’s approach through which instances in which payment moves to the corporate debtor in advance can be characterized as financial debt, it is possible that all pre-paying consumers may have to be considered as financial creditors. The features of the transaction between apartment buyers and real estate developers can be found in other industries too such as interior designing, or even the customization of any equipment where payments are made in advance. The 2018 amendment in combination with the Supreme Court decision in Pioneer seems to have diluted the meaning of consideration for time value of money which is a key element of financial debt and consequently relaxed the category of financial creditors.

Alternatives to Classifying Apartment Buyers as Financial Creditors

A more cohesive solution to the problem apartment buyers could have been crafted within the IBC without straining the definition of financial debt. Sections 18 and 36 exclude assets of a third party held in trust by the corporate debtor from the scope of the insolvency resolution and liquidation processes respectively. The driving force behind the amendment appears to be the delays faced by apartment buyers and non-delivery of apartments. A solution that would have focused on returning an apartment buyer’s money could have been devised using these sections. The protection of such advances by consumers in general would be a good practice to adopt. This was also suggested in the context of home owners in the United Kingdom whose had made substantial advances for home improvements. A Report of the UK Law Commission suggested that consumers’ pre-payment exceeding a certain amount be given priority in the event of liquidation. Such solutions could have been adopted within the Indian context as well.

In the context of liquidation, the amendment has not substantially changed the position of the apartment buyer. In Pioneer, the Supreme Court has observed that even after the 2018 amendment, the debt owed to apartment buyers would be unsecured. As unsecured financial creditors, they will be paid 4th as opposed to 6th (which was their position prior to the 2018 amendment). The underlying problem of unprotected consumer pre-payments could have been addressed by giving them a higher priority within the liquidation waterfall. This would have also reflected in the distribution of proceeds of an insolvency resolution plan because section 30(2)(b)(ii) requires such distributions to follow the scheme of the liquidation waterfall. The most concerning aspect of the 2018 amendment is thus not that it chose to empower apartment buyers against real estate developers but rather the modality used to achieve this. It will now be difficult to offer a justification to other stakeholders that are receivers of products (against advance payments) for being excluded from the category of financial creditors under the IBC. 


As noted at the outset, India uniquely differentiates between financial and operational creditors when it comes to their ability to initiate insolvency resolution proceedings and vote in the Committee of Creditors. This means that the constituents of each category must be clear and predictable. Though the IBC had enumerations (through an inclusive list) of what comprises a financial debt even prior to the 2018 amendment, all of them could be reconciled with the overarching definition of financial debt – the disbursement of sums against consideration for the time value of money. The 2018 amendment appears to have allowed a different category of persons to be characterized as financial creditors, thus reducing the predictability of how the definition of financial creditors will be applied to other transactions. The IBC, or any insolvency law for that matter, reflects the priorities of the society it governs. The present approach, however, appears to create tension between the policy imperative to reflect these priorities and fundamental concepts of the IBC. 

M.P. Ram Mohan & Vishakha Raj

[1] The Insolvency and Bankruptcy (Amendment Act) 2020 (No. 1 of 2020) amended the IBC requiring 100 allottees (apartment buyers) or ten percent of a real estate developers allottees, whichever is lesser, to jointly file an application for initiating the insolvency resolution process.  This means that a single apartment buyer cannot initiate the insolvency resolution process.  The Supreme Court of India has since upheld the constitutional validity of the 2020 Amendment in Manish Kumar v. Union of India.

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